Technology Forecasting Learning Objectives List the elements of a good forecast. Outline the steps in the forecasting process. Describe at least three qualitative forecasting techniques and the advantages and disadvantages of each. Compare and contrast qualitative and quantitative approaches to forecasting.

Learning Objectives Briefly describe averaging techniques, trend and seasonal techniques, and regression analysis, and solve typical problems. Describe two measures of forecast accuracy. Describe two ways of evaluating and controlling forecasts. Identify the major factors to consider when choosing a forecasting technique.

FORECAST: A statement about the future value of a variable of interest such as demand. Forecasting is used to make informed decisions. Long-range Short-range

Forecasts Forecasts affect decisions and activities throughout an organization Accounting, finance Human resources Marketing MIS Operations Product / service design

Uses of Forecasts Accounting Cost/profit estimates Finance Cash flow and funding Human Resources Hiring/recruiting/training Marketing Pricing, promotion, strategy MIS IT/IS systems, services Operations Schedules, MRP, workloads Product/service design New products and services

Features of Forecasts Assumes causal system past ==> future Forecasts rarely perfect because of randomness Forecasts more accurate for groups vs. individuals Forecast accuracy decreases as time horizon increases I see that you will get an A this semester.

Elements of a Good Forecast Timely Accurate Reliable Meaningful Written Easy to use

Steps in the Forecasting Process Step 1 Determine purpose of forecast Step 2 Establish a time horizon Step 3 Select a forecasting technique Step 4 Obtain, clean and analyze data Step 5 Make the forecast Step 6 Monitor the forecast “The forecast”

Types of Forecasts Judgmental - uses subjective inputs Time series - uses historical data assuming the future will be like the past Associative models - uses explanatory variables to predict the future

Judgmental Forecasts Executive opinions Sales force opinions Consumer surveys Outside opinion Delphi method Opinions of managers and staff Achieves a consensus forecast

Time Series Forecasts Trend - long-term movement in data Seasonality - short-term regular variations in data Cycle – wavelike variations of more than one year’s duration Irregular variations - caused by unusual circumstances Random variations - caused by chance

Forecast Variations Figure 3.1 Trend Cycles Irregular variation 90 89 88 Seasonal variations

Naive Forecasts Uh, give me a minute.... We sold 250 wheels last week.... Now, next week we should sell.... The forecast for any period equals the previous period’s actual value.

Naïve Forecasts Simple to use Virtually no cost Quick and easy to prepare Data analysis is nonexistent Easily understandable Cannot provide high accuracy Can be a standard for accuracy

Uses for Naïve Forecasts Stable time series data F(t) = A(t-1) Seasonal variations F(t) = A(t-n) Data with trends F(t) = A(t-1) + (A(t-1) – A(t-2))

Techniques for Averaging Moving average Weighted moving average Exponential smoothing

Moving Averages At-n + … At-2 + At-1 Ft = MAn= n Moving average – A technique that averages a number of recent actual values, updated as new values become available. Weighted moving average – More recent values in a series are given more weight in computing the forecast. Ft = MAn= n At-n + … At-2 + At-1 Ft = WMAn= n wnAt-n + … wn-1At-2 + w1At-1

Simple Moving Average Actual MA5 MA3 Ft = MAn= n At-n + … At-2 + At-1

Exponential Smoothing Ft = Ft-1 + (At-1 - Ft-1) Premise--The most recent observations might have the highest predictive value. Therefore, we should give more weight to the more recent time periods when forecasting.

Exponential Smoothing Ft = Ft-1 + (At-1 - Ft-1) Weighted averaging method based on previous forecast plus a percentage of the forecast error A-F is the error term,  is the % feedback

Example 3 - Exponential Smoothing

Picking a Smoothing Constant  .1 .4 Actual

Common Nonlinear Trends Figure 3.5 Parabolic Exponential Growth

Linear Trend Equation Ft = a + bt Ft = Forecast for period t t = Specified number of time periods a = Value of Ft at t = 0 b = Slope of the line

Calculating a and b b = n (ty) - t y 2 ( t) a 

Linear Trend Equation Example

Linear Trend Calculation y = 143.5 + 6.3t a = 812 - 6.3(15) 5 b 5 (2499) 15(812) 5(55) 225 12495 12180 275 6.3 143.5

Techniques for Seasonality Seasonal variations Regularly repeating movements in series values that can be tied to recurring events. Seasonal relative Percentage of average or trend Centered moving average A moving average positioned at the center of the data that were used to compute it.

Associative Forecasting Predictor variables - used to predict values of variable interest Regression - technique for fitting a line to a set of points Least squares line - minimizes sum of squared deviations around the line

Linear Model Seems Reasonable Computed relationship A straight line is fitted to a set of sample points.

Linear Regression Assumptions Variations around the line are random Deviations around the line normally distributed Predictions are being made only within the range of observed values For best results: Always plot the data to verify linearity Check for data being time-dependent Small correlation may imply that other variables are important

Forecast Accuracy Error - difference between actual value and predicted value Mean Absolute Deviation (MAD) Average absolute error Mean Squared Error (MSE) Average of squared error Mean Absolute Percent Error (MAPE) Average absolute percent error

MAD, MSE, and MAPE  Actual  forecast MAD = n MSE = Actual forecast) - 1 2   n ( MAPE = Actual forecast  n / Actual*100) (

MAD, MSE and MAPE MAD MSE MAPE Easy to compute Weights errors linearly Squares error More weight to large errors MAPE Puts errors in perspective

Example 10

Controlling the Forecast Control chart A visual tool for monitoring forecast errors Used to detect non-randomness in errors Forecasting errors are in control if All errors are within the control limits No patterns, such as trends or cycles, are present

Sources of Forecast errors Model may be inadequate Irregular variations Incorrect use of forecasting technique

Tracking Signal  Tracking signal = (Actual - forecast) MAD Ratio of cumulative error to MAD Tracking signal = (Actual - forecast) MAD  Bias – Persistent tendency for forecasts to be Greater or less than actual values.

Choosing a Forecasting Technique No single technique works in every situation Two most important factors Cost Accuracy Other factors include the availability of: Historical data Computers Time needed to gather and analyze the data Forecast horizon

Operations Strategy Forecasts are the basis for many decisions Work to improve short-term forecasts Accurate short-term forecasts improve Profits Lower inventory levels Reduce inventory shortages Improve customer service levels Enhance forecasting credibility

Supply Chain Forecasts Sharing forecasts with supply can Improve forecast quality in the supply chain Lower costs Shorter lead times Gazing at the Crystal Ball (reading in text)

Exponential Smoothing

Linear Trend Equation

Simple Linear Regression